Enforcement Watch Issue 5 | September 2011

This edition of Enforcement Watch looks both at the messages of the enforcement cases in the last few months and at what changes on the horizon are likely to mean for firms and individuals in the shape of future enforcement.

Editor's Note

The enforcement direction of travel has been clear for some time, both for the FSA and for the new FCA. In that regard, as the enforcement case highlights below show, the FSA continues to set record penalties. Particularly interesting in this period however, have been the cases that consider the possible checks on the FSA.

As for matters on the horizon, we have again highlighted those aspects that we consider potentially very important for future enforcement - a number of which may have slipped through rather unnoticed. We hope that you find our commentary on them helpful.

On the Horizon

Lessons from the Enforcement Annual Performance Account

Together with its Annual Report for the year April 2010-March 2011, the FSA published a summary of its enforcement performance for the year. Its purpose is to consider the fairness and effectiveness of its enforcement activity. Whilst in many senses, this is a document that looks back rather than looks at matters “On the Horizon”, there are a number of aspects of it that give clues to the future and that are worthy of note. Amongst the more interesting are set out below.

Credible deterrence focus

The FSA clearly considers that its credible deterrence approach is working, and it remains committed to it. It is a long term strategy and the FSA says it “will continue to work hard to build upon the momentum we have already gained in this area”.

It says that it focuses on cases where it thinks it can make a real difference to consumers and markets, using enforcement strategically as a tool to change behaviour in the financial services industry.

In order to achieve credible deterrence, the FSA believes that wrongdoers must not only realise that they face a real and tangible risk of being held to account, but must also expect to face a significant penalty. Notably, it says that it considers that action against individuals has a greater deterrent effect than action against firms. It is committed to holding senior managers to account for competency and integrity failings.

The FSA says that a “significant proportion” of its time continues to be spent responding to international requests for assistance in enforcement related matters. The numbers have steadily risen over the years, and the FSA expects them to continue to do so. In 2010/11, the FSA received over 900 formal requests for assistance pursuant to regulatory or criminal investigations.

Matters beyond the public gaze

Three aspects are worth mentioning. The first is in the area of Threshold Conditions (TCT). Here, the FSA may for example inform the firm or individual that unless they comply with the Threshold Conditions, disciplinary action will follow. The FSA says that this is often sufficient to produce a change in behaviour. In the year in question, 88 firms remedied Threshold Conditions breaches on this basis. Where they do not comply, the FSA says that it takes disciplinary action. In the past year, it took action against 110 firms for TCT breaches (which resulted in published Final Notices or Supervisory Notices).

The second is the area of Private Warnings. These may be issued where the FSA has concerns about the behaviour of a firm or approved person, but where it decides it is not appropriate to bring formal disciplinary action.

However, the Private Warning forms part of the subject’s compliance history and it may influence the FSA’s decision to start disciplinary action in any relevant future breaches and can be an aggravating factor for the level of financial penalty. In 2010/2011, the FSA issued only 20 Private Warnings.

The third area is where the FSA concludes disciplinary cases on the basis of taking no further action. The FSA is keen to say that the figure will vary each year. Last year, over 10% of cases closed (excluding Threshold Condition cases) with no action being taken.

Dear CEO letter to wealth managers suggests action to come

In this letter the FSA reported on its review of suitability of client portfolios at 16 wealth managers firms from across the spectrum. It found:

14 out of 16 firms were judged to pose a medium or high risk of detriment to their consumers based either on the unsuitability of their portfolios or because the suitability of the portfolio could not be determined.

79% of the files reviewed had a high risk of unsuitability, or suitability could not be determined.

67% of files reviewed were either inconsistent with the client’s stated attitude to risk or the firm's house models.

Where suitability could not be determined, the FSA encountered a number of failures in terms of information about the client. For example, absence of or out of date KYC information and inadequate risk profiling.

The FSA said that it was involved in ongoing regulatory action with these firms to mitigate these risks.

As to the recipients of the letter, the FSA (i) asked them to respond to acknowledge that they had read and understood its contents and considered the implications for their firms; and (ii) “expected that they would want to consider” the client information in their client files and whether they were likely to satisfy their obligations regarding customers’ desired investment portfolios. It set out some suggestions.

Suitability, and the ability to demonstrate it, is plainly an important area in retail business. With the combination of extremely serious findings in the sample, together with the warning to other firms, it is a racing certainty that enforcement action will follow in future.

The FSA has now published a document about how the FCA plans to approach the delivery of its objectives. The document describes its contents as representing “initial thinking”, which will be further refined. As regards enforcement, there is little there that is new. However, the following points are interesting to note.

As a general proposition, the intention is for the FCA to be “tougher and bolder”, and it will use its new powers of intervention and enforcement.

It is expected that the FCA will intervene more strongly. One of the matters that it will focus on is preventative action.

There is also likely to be a greater emphasis on thematic work, dealing with risks that are particular to a given sector. We have previously commented on how thematic work by the FSA has led to increased enforcement activity and is likely to continue to do so in the future.

A key task of the FCA will be to ensure that the conduct of market participants is compatible with fair and safe markets. This means not only working to deter market abuse and pursuing it effectively where it does occur, but also to prevent other behaviour that would harm confidence in the integrity of the markets.

The notion of credible deterrence permeates the document. For example, it talks generally about building on the much trumpeted FSA credible deterrence, and more specifically about ensuring that penalties and consumer redress schemes bring it about.

It is explicitly stated that the FCA’s more interventionist approach and lower tolerance for consumer detriment is likely to require further enhancement of the FSA’s “strong activity in enforcement”. It sees a likely increase in enforcement cases, and also the need for greater enforcement resource.

The FCA approach is almost certain in our view to lead to greater enforcement activity, for the reasons we have previously described and echoed by those above. It is to be hoped that it adopts a proportionate approach. The FSA will now consider how best to implement what it sets out in the document we describe above.

Criminal cases continue to go through the system

There has been the usual diet of notifications of steps taken by the FSA in relation to criminal matters. Some of these are at an early stage and may well emerge again in the future if they work their way through the system. Others represent action that is at an end.

On 28 June, the FSA executed search warrants on two premises in Dorset as part of an on-going investigation into the operation of an unauthorised collective investment scheme. An individual was arrested, but no-one had been charged by that stage.

On 4 August, the FSA announced that it had charged three people with insider dealing offences. The alleged offence relates to trading in shares of Océ NV between February 2009 and November 2009.

On 22 August, the FSA announced that, following an FSA investigation, three men were sentenced to a total of 19 years in jail for a boiler room fraud. The Wilmots (Kevin, Christopher and Tomas) controlled a syndicate of boiler room operations that defrauded an estimated 1,700 investors of £27.5m in total. Many of the victims were elderly or seriously unwell. The fraud resulted in around £14m of losses.

AML enforcement cases on the agenda

We have long been saying that the FSA’s increased thematic work will lead to increased FSA enforcement action. This will again be the case with its anti-money laundering (AML) work.

(It also points to what is likely to happen in enforcement generally in the future under the new FCA, as the FCA is planning to adopt a similar intrusive style of regulation.)

In June 2011, the FSA published the results of its AML thematic work, “Banks’ management of high money laundering risk situations”. The main objective of the FSA’s work had been to assess whether banks (i) had robust and proportionate systems and controls in place to identify, detect and prevent the misuse of correspondent banking facilities, (ii) meet the requirements to identify the originators of international wire transfers, and (iii) reduce the risk of corrupt Politically Exposed Persons (PEPs) and other high-risk customers misusing the UK banking system.

Its findings showed that:

On correspondent banking, it found the quality of systems and controls varied.

Banks were generally complying with the wire transfer regulations, although the FSA is still keen to encourage a more collaborative effort within the regulated community to ensure higher standards.

The FSA’s primary concern was over banks’ relationships with high risk customers and Politically Exposed Persons (PEPs). The concerns and issues are described in the following paragraphs.

Of the banks in the sample, over a third of banks’ senior management approval of PEPs was vague, and records of approval did not contain sufficient detail, including whether or not serious allegations were factored into the final decision making process. In addition, ongoing monitoring and reviews of relationships were often mechanistic, resulting in weak judgements. In some cases, approvals relied on explanations from customers and relationship managers that had no supporting evidence. In some banks, the FSA found that some key staff did not even understand the definition of a PEP, including some MLROs.

Over half the banks visited failed to carry out robust enhanced due diligence in high risk situations, sometimes failing to identify, record and review credible adverse allegations about their clients.

Around a third of the banks visited appeared unwilling to turn away or exit very profitable business relationships even though there appeared to be an unacceptable risk of handling the proceeds of crime. In addition, three quarters of banks failed to take adequate measures to establish the legitimacy of a PEPs source of wealth3. This was of concern, in particular where the bank was aware of significant adverse information about the customer’s or beneficial owner’s integrity.

The FSA stated that its main conclusion was that around three quarters of banks in its sample, including the majority of major banks, are not always managing high risk customers and PEP relationships effectively and must do more to ensure they are not used for money laundering. Where appropriate, it would use enforcement to reinforce key messages.

In September this year, the FSA described itself as extremely concerned by the above findings. It re-iterated that, on many occasions, it had found “serious weaknesses in systems and controls and questionable judgements made by firms”. It stated that it expected significant improvements in banks’ systems, controls and decision making. In the June report, it was said that two cases had been referred to enforcement. In September 2011, it echoed the fact that cases had been referred to enforcement, although it did not say how many at that stage. It added rather ominously that there was the prospect of more to come.

Firms would do well to heed the FSA’s warnings and to observe its guidance. The June report outlined proposed guidance. The finalised guidance will be included in “Financial Crime; a guide for firms”. The consultation on this guidance (CP11/12) has just closed.

3 Those with long memories will recall the FSA’s concerns in 2001 about money laundering risks attached to accounts related to Sani Abacha of Nigeria. The FSA has said that its recent AML findings relating to high risk customers are similar to those concerning the Abacha related accounts back in the day.

FSA pushes for enhanced FCA powers

The FSA has published its memorandum to the Joint Committee on the draft Financial Services Bill. Whilst the memorandum covers a wide number of areas, we highlight two that, if they go through, are likely to have a real impact on enforcement/contested applications in future.

The FSA memorandum welcomes the proposal for publication that appears in the draft Financial Services Bill. However, it argues that it does not go far enough. Specifically, it objects to the draft requirement to consult the subject of the Warning Notice before it publicises it. It says this will undermine the effectiveness of the power as most, if not all, firms and individuals are likely to object to details being published. No doubt with one eye on the Swift Trade case reported on elsewhere in this issue (See Enforcement Watch 5 “Court allows publication of Decision Notice concerning £8m Market Abuse Fine”), it fears satellite litigation will result. It says that its “strong preference” would be to remove the requirement to consult. We commented in the last edition that the proposed safeguards for the subjects of action appeared extremely limited. If implemented, the FSA’s suggestion would limit them yet further in a very dangerous way.

The second relates to approvals of those carrying out significant influence functions (SIFs). Under the new regime, there will be some individuals who are required to be approved both by the PRA and the FCA (See Enforcement Watch 2 “Enforcement after the abolition of the FSA”4). The draft Bill provides that the PRA alone is responsible for approving individuals performing SIFs in dual regulated firms. Whilst they would expect the PRA to consult the FCA, the future senior management of the FCA have a “significant concern” about this. They feel strongly that the Bill should go further and require the FCA's consent to the approval.

Essentially, the FCA wants a right of veto for such individuals. This looks to have some of the characteristics of a turf war. It is unlikely to be one that will benefit potential SIFs. On the ground, we have seen how the FSA is already trying to raise the bar for certain approvals. This may well make it yet more difficult, leading to more contested approval applications.

4 In EW2, reference was made to the CPMA. That was the working name at the time of what has now been named the FCA.

Raft of UCIS cases

The FSA has concluded four different sets of Unregulated Collective Investment Scheme (UCIS) cases in the period, leading to a host of prohibitions and financial penalties.

Details of the cases

Inevitably, the four sets of cases were not limited to UCIS issues. However, UCIS is a very important topic for the FSA. It is a dominating and uniting theme of the four sets of cases and appears to be the principal message the FSA is trying to convey through them. Accordingly, although other breaches were also in play which no doubt contributed towards the sanctions imposed, we do not cover them below.

The first set of cases (8 July 2011) relates to Andrew Ruff and Richard Lindley, the two directors engaged in the day to day running of an IFA network called Alpha 2 Omega (UK) Limited (“A20”).

A20 went into administration on 25 January 2010. At that time, it had 47 Appointed Representatives, employing around 101 advisers, a number of whom recommended a large volume of high risk products, including UCIS funds. There were serious compliance failings in relation to the network; the firm’s failings were systemic, serious and basic.

Ruff was in charge of compliance oversight, and received a significant influence prohibition, together with a fine of £28,000 (down from £40,000 after a 30% discount for early settlement). The lack of oversight was particularly serious, given the significant amount of high risk business recommended to retail clients by certain advisors, particularly recommendations to invest in UCIS. He was fined £28,000 (down from £40,000 after a 30% discount). The FSA found a serious lack of competence and capability. It prohibited him from carrying on any significant influence function.

Lindley was not in charge of compliance. The FSA found that he relied entirely on the knowledge and experience of Ruff to oversee the clients effectively. Further, he acknowledged that he only had a high level understanding of UCIS and the types of consumers to whom these could be promoted and therefore sold. He received a fine of £14,000 (down from £20,000 after a 30% discount for early settlement). He received no prohibition.

The second set of cases relates to former directors of Best Advice Financial Planning Limited, Paul Banfield and Anthony Moss (20 July 2011).

Best Advice was a small independent financial advice firm based in Surrey. The FSA had concerns about the firm and appointed investigators, who reviewed 22 separate customer files. The FSA found that these customers were advised to invest in UCIS, but found no evidence that the firm either understood the regulatory requirements relating to the promotion of these investments or took reasonable care to ensure customers received suitable advice.

Both Moss and Banfield admitted that they did not fully understand the regulatory restrictions on UCIS, despite their firm recommending them to customers. The FSA concluded that weaknesses in the firm’s systems and controls had resulted in customers being exposed to the risk of receiving unsuitable advice.

Banfield was a director and also held the customer function (CF30). Moss was a director, was responsible for compliance and apportionment and oversight, was the MLRO and was an adviser for part of the time. The FSA concluded that both men failed to meet the minimum regulatory standards in terms of competence and capability and that they were not fit and proper to perform any controlled function in relation to any regulated activity carried on by any authorised person. It therefore imposed a prohibition order on them. The FSA fined Banfield £10,500 (down from £15,000 following settlement discount), and would have fined Moss £20,000 but for the evidence of financial hardship.

The FSA indicated that it would be minded to revoke the prohibition order on both men if they could satisfy the FSA that they had taken adequate steps to remedy their lack of competence and capability. This indication was possibly due to its finding both that (i) neither man had deliberately ignored or sought to circumvent the statutory restriction on the promotion of UCIS and (ii) the sale of regulated investment products represented a small proportion of the total business of the firm during the relevant period.

The third set of cases published by the FSA (15 September 2011) relates to Rockingham Independent Limited The firm exposed 426 customers to the risk of receiving unsuitable advice, 39 of whom were advised to invest in UCIS. It was clear that neither Rockingham nor the individuals below properly understood the regulatory restrictions on the promotion of UCIS.

Rockingham was fined £35,000 (down from £50,000 after settlement discount). It also stopped selling any UCIS and agreed to conduct a past business review to determine whether redress was needed.

Its MD, Stephen Hunt, was banned from holding any significant influence function (SIF) and the customer function (CF30) relating to any regulated activity promoting or recommending UCIS.

Its compliance director, Jonathan Edwards, was similarly banned from holding any significant influence function (SIF) and the customer function (CF30) relating to any regulated activity promoting or recommending UCIS. He was also banned from holding any compliance role. Sensibly, he had highlighted that he did not have sufficient time or knowledge to perform his compliance role. However, foolishly, he had continued to perform the role.

Gary Forster held a CF30 customer function role, and also acted as Chief Executive (without approval). He was also banned from holding any significant influence function (SIF) and the customer function (CF30) relating to any regulated activity promoting or recommending UCIS.

The fourth case relates to Ian Jones (21 September 2011). Jones was director, compliance officer, MLRO and customer adviser at Specialist Solutions Limited (SSL), an IFA. SSL was fined in April this year for failings relating to the sale of UCIS (See Enforcement Watch 4 “Thematic UCIS visit leads to enforcement action”). Jones has now been punished for his role in this. Jones was prohibited both from performing any SIF and any customer function in relation to the promotion of UCIS. He was also fined £20,000 (down from £16,000).

The FSA clearly liked the fact that (i) Jones had made significant improvements to SSL's sales processes and compliance arrangements since the failings were identified; and (ii) under his management, SSL had undertaken a past business review and agreed in principle to contact customers who may have been mis-sold UCIS with a view to providing redress. The FSA said that it would be minded to revoke the prohibition order on Jones’ application if he could demonstrate that he had taken adequate steps to remedy his lack of competence and capability.

One aspect of the FSA’s actions is to put out the message as strongly as it can about UCIS. For example, in the Moss/Banfield case, the FSA release stated that “UCIS are rarely suitable for retail investors… Even when they are recommended they are unsuitable for anything more than a small share of a portfolio.” The FSA specifically commented on the case that “We want firms to read the details of this case … and learn from them. We’ve seen a proliferation of firms offering UCIS so it is absolutely vital they do their homework before recommending these schemes to investors.” These cases are vital reading material for anyone involved with UCIS.

Willis Limited has been fined £6.895 million for failings in its anti-bribery and corruption systems and controls. Disregarding the 30% discount for early settlement, the fine would have been £9.85m.

Details of the case

The case relates to breaches of FSA rules relating to anti-bribery and corruption systems and controls.

Willis Limited (a UK company) is one of the largest insurance and reinsurance brokerage and risk management firms in the UK. Between January 2005 and December 2009, Willis made payments to overseas third parties who assisted it in winning and retaining business from overseas clients, particularly in high risk jurisdictions. Whilst this can in principle be perfectly permissible, the FSA found that Willis had failed in a number of respects. It found that, up until August 2008, Willis Limited failed to:

Ensure that it established and recorded an adequate commercial rationale to support its payments to overseas third parties. For example, whilst its policies required the reason for the commission share to be recorded on the relevant form, when the relevant form was completed by the associate or Business Unit Compliance Officer, they only used the term ”introducer” or “producing broker” rather than any specific and detailed explanation of the nature of the third party’s role;

Ensure that adequate due diligence was carried out on overseas third parties to evaluate the risk involved in doing business with them. For example, in relation to the risk of corrupt payments, this should have included taking reasonable steps to ensure whether the third party was connected to the insured, the insurer or public officials; and

Adequately review its relationships on a regular basis to confirm whether it was still necessary and appropriate for Willis to continue with the relationship.

Further, the FSA found that:

Willis failed to ensure that the relevant senior management committees received sufficient performance information on the policies to allow them to assess whether bribery and corruption risks were being mitigated effectively.

These failures contributed to a weak control environment surrounding payments to overseas third parties and gave rise to an unacceptable risk that these payments could be used for corrupt purposes, including paying bribes.

The FSA found that Willis had breached Principle 3 of the FSA's Principles for Businesses and Rule 3.2.6 R of SYSC (the FSA’s Senior Management Arrangements, Systems and Controls Handbook). The FSA recognised that Willis had taken significant steps to address the failings that it had identified and that it was committed to carrying out a review of its past payments to third parties. Nevertheless, it fined Willis £6.895m. Without the discount for early settlement, the fine would have been £9.85 million.

Comment

The Willis fine follows the £5.25m imposed on Aon Limited in January 2009. It is the biggest fine imposed by the FSA in relation to financial crime systems and controls to date. The action by the FSA shows how seriously it takes, not only the firm having in place appropriate systems and controls, but also ensuring that those systems and controls are adequately implemented and monitored.

Although it is not an Act enforced by the FSA, it should be noted that the fine also comes against the background of the much trumpeted and debated Bribery Act 2010. The Bribery Act came into force in July of this year. It is the most comprehensive Act of its kind ever introduced in the UK and requires all businesses to comply with wide ranging anti-corruption obligations.

Quite separately from the Bribery Act, FSMA authorised firms are under a regulatory obligation to identify and assess corruption risk and to put in place and maintain policies and processes to mitigate corruption risk.

In a serious case of deception (amongst other things), the Upper Tribunal fined Michiel Visser and Oluwole Fagbulu of hedge fund manager Mercurius Capital Management Ltd (“Mercurius”) £2m and £100,000 respectively. It also banned them both from performing any role in regulated financial services.

Details of the case

Mercurius acted as a UK based investment manager for a fund based in the Cayman Islands. The fund had approximately 20 investors and, for most of the time, had approximately €35m. Visser was a Director (CF1), Chief Executive and investment manager (CF27). Fagbulu held the roles of Compliance Oversight (CF10) and Finance (CF13).

The case was initially decided by the RDC, who found heavily against the two men. Both men referred the matter to the Upper Tribunal. Visser did not attend the Tribunal hearing on the basis of ill-health, and his lawyers ceased acting for him one week before the Tribunal hearing.

The case centred on 4 allegations:

That they breached investment restrictions in the fund prospectus and in a side letter. The Tribunal found that the breaches were proven and that they had moreover been knowing and deliberate, and that no steps had been taken to remedy the position;

That the two men committed deliberate market abuse. The Tribunal determined that between May and June 2007, Visser and Fagbulu had committed deliberate market manipulation. In essence, they had made a number of small, yet outrageously high bids for shares in a company called Sandhaven Resources plc (“Sandhaven”), in which the fund had a position. Sandhaven was admitted on the PLUS market. On the PLUS market the closing price of a security is set at the mid point between the lowest offer and the highest bid. Therefore, the very high bids for Sandhaven had the effect of distorting the market price. Visser and Fagbulu did this to artificially inflate the fund’s NAV. Fagbulu did attempt to argue that he had simply been acting on Visser's instructions in executing some of the trades in Sandhaven. However, the Tribunal determined that Fagbulu had known what he was doing;

That Visser and Fagbulu artificially inflated the fund’s Net Asset Value (“NAV”). The FSA’s case was that Visser and Fagbulu twice borrowed money at exorbitant rates of interest and then executed two sets of fictitious transactions to inflate the fund’s NAV. The FSA argued that these transactions had no real commercial purpose other than the inflation of the NAV. The Tribunal agreed with the FSA. Again, Fagbulu argued that he had simply been guided by Visser. The Tribunal accepted that Visser had initiated the transactions but held that Fagbulu had been involved in them and must have known that they were effectively artificial transactions; and

That they failed to inform investors of certain key information about the fund. Examples included the (deliberate) breach of the investment restrictions in the prospectus and the failure to inform investors that BNP Paribas had resigned as the fund’s prime broker. The Tribunal held that whilst Mercurius was under no obligation in terms of the prospectus to provide regular reports to investors, when it did in fact produce regular reports, it had a duty to ensure that these were not misleading. Instead, Visser and Fagbulu had made a deliberate decision that all reports sent to investors would paint a rosy picture of the fund. The Tribunal held that this was a deliberate attempt to deceive investors. The fund eventually collapsed resulting in the loss of around €35m of investors’ funds.

Both men were found by the Tribunal to have breached Principle 1 of the FSA’s Statements of Principle for Approved Persons (Integrity) and to have engaged in market abuse. They were both banned from performing any role in future in regulated financial services. Both men were also fined.

The Tribunal commented that Visser’s conduct was worse than any other ever seen by the Tribunal, therefore warranting a £2m fine.

Whilst Fagbulu’s conduct was not as serious as Visser’s, the FSA argued that his failings were particularly egregious because of his compliance oversight role. This was accepted by the Tribunal. In mitigation, Fagbulu did accept some of the blame and was co-operative. He was also able to provide some evidence of potential financial hardship. This evidence resulted in his fine being decreased from £350,000 to £100,000.

Comment

In some senses, the sanctions handed down come as no real surprise. This was an integrity case, and the individuals were found to have acted in a deliberate, deceptive and repeated way. The Tribunal described it as “at the most serious end of the scale”.

The £2m fine imposed on Visser is the largest fine ever imposed on an individual (disregarding any part relating to disgorgement). £2m was the figure originally imposed by the RDC. The Tribunal noted that, had they been coming at the matter afresh, they would probably have imposed a larger fine. However, it was interesting to see in their reasoning that they were mindful that respondents should not be put off appealing a decision to the Tribunal by the risk that the Tribunal would increase the penalty. Instead, it said that the Tribunal should only increase a penalty imposed by the RDC “in the clearest of cases, where it is plain that the RDC has misdirected itself.”

1 The Upper Tribunal released its decision on 9 August 2011; the FSA published its press release concerning it on 15 August; the FSA published the two Final Notices on 20 September 2011

Sir Ken Morrison, the former Chairman of supermarket chain Wm Morrison has been fined £210,000 (reduced by 30% for early settlement). The fine relates to his failure to make the appropriate disclosures under the Disclosure and Transparency Rules (DTR) of the reduction in his shareholding and voting rights in Wm Morrison.

Details of the case

Sir Ken is widely credited for taking the family business from an annual turnover of £50,000 in the early 1950s to an annual turnover of £13 billion.

Shortly after his retirement as Chairman of Wm Morrison, the company announced on 28 March 2008 that he had a notifiable holding of voting rights of 6.38% (a holding worth over £450m). After the announcement on 28 March 2008, there were no further shareholding notifications made concerning Sir Ken’s holdings until 1 March 2011, even though he had reduced his holdings during that period to 0.9%.

The DTR are designed to enhance market transparency and provide investors with timely information regarding voting rights. In contravention of the DTR, Sir Ken failed to notify Wm Morrison on four separate occasions when his voting rights fell below 6%, 5%, 4% and 3%.

The FSA considered that Sir Ken’s failings were serious due to his prominent position and the significant delay in his eventually making the required notification. Sir Ken’s explanation for the failure to notify in good time is that he was not aware of the requirement to do so. There is no suggestion that his failure to do so was either deliberate or reckless.

While Sir Ken did not financially benefit from his breaches, his failure to notify Wm Morrison of the changes to his shareholding resulted in Wm Morrison not being in a position to update the market in accordance with the rules. In fact, there was limited actual effect on the orderliness of, or confidence in, markets as a result of the breaches. The FSA fined him £210,000 (after applying a discount for early settlement). Were it not for this early settlement discount, the penalty would have been £300,000.

Given that Sir Ken did not financially benefit from his breaches and that he had no relevant income, the FSA effectively had a blank canvas of £0 as a starting point for setting the penalty. It adjusted it upwards to £300,000 (before early settlement discount) to reflect what it described as the seriousness of the breaches and the need for credible deterrence. On this latter aspect, it made the point that Sir Ken is an extremely wealthy individual who held a prominent position within the industry. The FSA’s actions shows its zero tolerance approach in the area, and looks to be all about setting down a marker for the future.

Jason Geddis committed market abuse on the London Metal Exchange (LME) on one day in November 2008. By a Decision Notice, the FSA ruled that Geddis had committed market abuse and that he should be fined and prohibited from any regulated activity. Geddis referred the matter to the Upper Tribunal on the question of sanction only. The Tribunal ruled that a public censure alone was sufficient.

Details of the case

Geddis had 20 years experience working in LME-related roles. On one day in November 2008, he had built up a dominant position in Tom-Next Standard Lead Contracts, giving rise to a requirement to conduct himself in certain ways. He failed to do so. Instead, he made various inflated offers to lend. Had these trades been allowed to stand, his employer would have made approximately $1.4 million.

Very shortly after the end of the open outcry session, in a state of high anxiety, Geddis contacted his line manager, in order to deal with what he had done. He and the firm worked to resolve the position, which involved the firm not realising its trading profit and also its paying compensation of over £30,000 to other market participants. The LME subsequently fined the firm. Geddis was disciplined by his employer, and received a final written warning.

The FSA investigated Geddis for market abuse. Geddis was made redundant in December 2009 and, due to the ongoing investigation, he was not able to find suitable alternative employment.

The FSA issued a Decision Notice in June 2010. It concluded that he had committed market abuse by means of an “abusive squeeze”, and that he lacked integrity such that he was not fit and proper. It imposed a prohibition order on him from performing any function in relation to any regulated activity. In addition, it would have fined him £100,000, but due to his financial situation, this was reduced to £25,000. Geddis referred the matter to the Tribunal only on the question of sanction.

The Tribunal approached the question of sanction very differently. It found Geddis to be an honest and careful witness, who tried to assist the Tribunal to the best of his ability. It reviewed evidence from a variety of sources that were testament to his integrity, and positively concluded that he was a man of integrity. It found that the undisputed market abuse was not premeditated. It accepted his explanation that he got caught up in the excitement of trading. Having realised his error, he did the right thing by immediately calling for assistance. His failure was not a failure of integrity, but a failure to take sufficient care, whilst holding a dominant position, to avoid creating a disorderly market.

The Tribunal considered the appropriate sanction. Regardless of his financial position, it did not consider that a fine was appropriate. Neither did it endorse the prohibition order. Geddis was a man of integrity, who demonstrated his lack of care resulting in a disorderly market on a single occasion, in a manner that the Tribunal was sure he would never repeat. He had learned his lesson, and was fit and proper. Instead, it ruled that a public censure was sufficient.

Comment

As the FSA has been trumpeting for some time now, it wants to establish credible deterrence. In doing so, it has been pushing for aggressive punishments. What is interesting about this case, as a general proposition, is that it is evidence of a real check by the Tribunal when it thinks the FSA has gone too far. As to the specifics of the case, it shows the kind of issues that may weigh heavily with the Tribunal in considering how far the FSA puts into practice the various pieces of guidance about sanctions and fines contained in the Enforcement Guide and in DEPP. Practitioners would do well to study this case.

The FSA’s interpretation of the Tribunal ruling can be seen clearly in its press release: “The FSA considers market abuse, particularly by market professionals, to be a serious matter and we will continue to take action to deter such misconduct. However, it will be only in rare cases, where the outcome is limited to a public censure.” The FSA is making its position going forward clear.

2 This is the date of the Upper Tribunal decision. The FSA then publicised this on 2 September, and subsequently published its Final Notice on 20 September.

After two Court hearings and a ruling of the Upper Tribunal, all concerned with whether publication could be prevented, the FSA has published a Decision Notice against Swift Trade Inc for market abuse. This is the first interpretation of the FSA’s wide new powers to publish Decision Notices.

Details of the case

When the internal FSA tribunal (the RDC) makes a finding against a respondent, that finding results in a Decision Notice. The respondent can appeal that Decision Notice to the Upper Tribunal. Until last year, the FSA was not permitted to publish Decision Notices. However, on 12 October 2010, the FSA gained the right to do so in certain circumstances (See Enforcement Watch “FSA presses on with enforcement sanctions changes”). This can have very serious consequences for respondents, as they may successfully appeal to the Upper Tribunal, but have a harmful finding published against them in the meantime.

By a Decision Notice in May, the RDC found that Swift Trade (a non FSA authorised Canadian company with global operations) had systematically and deliberately engaged in a form of manipulative trading known as “layering”. In the FSA’s opinion, between January 2007 and January 2008, Swift Trade’s manipulative trading caused a succession of small price movements in a wide range of individual shares on the LSE, from which Swift Trade made substantial profits. The FSA decision was to fine it £8m. Swift Trade appealed the finding to the Upper Tribunal.

But, would the FSA publish the Decision Notice in the meantime? Under the legislation that came into force in October last year, the FSA “must publish such information about the matter to which a decision notice … relates as it considers appropriate.” However, the legislation says that it may not do so if it would in its opinion “be unfair to the person with respect to whom the action was taken.” The FSA issued guidance on the topic, which came into force in March of this year. Significantly, it said that it “will normally not decide against publications solely because it is claimed that publication could have a negative impact on a person’s reputation.”

Unsurprisingly, the FSA wanted to publish. Swift Trade commenced High Court judicial review proceedings to challenge the FSA’s decision to publish the Decision Notice. In an injunction application in June, the High Court held that it was arguable that the FSA Guidance does not take a sufficiently nuanced approach to “appropriateness”. It granted an injunction on 9 June 2011 to restrain publication of the Decision Notice.

However, an injunction at that stage is only a holding measure. It was made pending an application by Swift Trade to the Upper Tribunal about whether the Decision Notice should be published. The Upper Tribunal heard the application and rejected the need to prohibit publication. It rejected for example the argument that publication would unfairly prejudice the investigation being carried out by the Canadian regulator.

With the Upper Tribunal having rejected the application, the FSA considered afresh whether to publish. Again, unsurprisingly, it decided to do so. Again, Swift Trade applied to the High Court to try to prevent it. This time, the Court had the ruling of the Upper Tribunal, and rejected the application to prohibit publication. It found amongst other things that:

the conclusions reached in the Decision Notice were already in the public domain by virtue of the publication of the Tribunal’s reasoned judgment;

it was much more likely than not that the FSA’s broad view of its powers (as set out in the FSA Guidance) would be accepted were it to be tested at a full hearing, especially given that it was Parliament’s intention to confer a broad discretion on the FSA.

Comment

The new power to publish Decision Notices has a potentially very serious impact on those who are on the wrong end of an RDC finding. The question of whether the FSA will publish a Decision Notice pending an appeal can have very serious consequences for businesses and individuals.

This case shows the view taken by the Court (albeit a lower Court) that the legislation confers a broad discretion on the FSA. It also shows how the FSA is likely to choose to exercise it.

Having said that, it does not mean that the FSA will always be able to publish a Decision Notice. On that topic, some interesting comments can be found amongst the judgments in the various hearings described above. For example, in the second High Court case, it was said that the witness statement the Judge had seen “contained the bare assertion that, if the decision notice were published, the value of its shares would be adversely affected.” The suggestion was that something beyond bare assertion may have been helpful to the case brought. This was a sentiment echoed in the Upper Tribunal, which said that an applicant seeking to demonstrate potential unfairness had to “provide cogent evidence of how that unfairness may arise and of how he could suffer a disproportionate level of damage.” This case is very unlikely to be the last word on publication.